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IRS Issues Interim Guidance for Foreign Bank and Financial Accounts Penalties; Congress Changes Deadline for Filing

Tax Alert | August 17, 2015
By: John Eagan, Kevin Koscil and Suzanne Prybella

The Internal Revenue Service (IRS) recently issued interim guidance that adopts new procedures for the calculation of the Foreign Bank and Financial Accounts (FBAR) penalty for the failure to report offshore financial accounts. The guidance is effective immediately and it applies to all open FBAR penalty cases. 

The IRS expects to incorporate the new procedures into the Internal Revenue Manual, which means that IRS agents will follow the procedures during a tax examination with offshore account issues. As such, the new procedures are not intended to apply to FBAR issues that are subject to the Offshore Voluntary Disclosure Program or the Streamlined Filing Compliance Procedures Program since these Programs have their own FBAR penalty structures. 

The new guidance is important for taxpayers because the FBAR penalty calculation under the guidance is more aligned with the approach used by the IRS in the Voluntary Disclosure and Streamlined Procedures Programs. Prior to the new guidance, the FBAR penalty for a non-willful violation was up to $10,000 per account per year and the FBAR penalty for a willful violation was the greater of $100,000 or 50% of the balance in the account at the time of the violation. 

For example, assume a taxpayer had four unreported offshore accounts with an aggregate annual balance of $500,000 and he failed to file FBARs for six years. The non-willful FBAR penalty could be up to $10,000 per account per year, or $40,000 per year, for a total of up to $240,000 ($40,000 for each of the six years) regardless of the account balance; however, under mitigation guidelines, the IRS often reduced the $10,000 per account penalty if the account balance did not exceed $250,000. Since the aggregate annual account balance in our illustration was $500,000, the mitigation guidelines would not apply and the non-willful FBAR penalty would likely be $240,000. 

Continuing the illustration, the taxpayer could be penalized 50% of the account balance per year if willfulness was involved. Based on an aggregate annual account balance of $500,000, the annual willful FBAR penalty would be $250,000, or $1,500,000 for six years, even though the aggregate annual account balance was only $500,000. For purposes of these illustrations, we have assumed that the taxpayer had unreported income from these accounts. If the taxpayer actually reported the income but did not file the FBARs, then the IRS has Delinquent FBAR Submission Procedures that allow the late FBARs to be filed without any penalties. 

Under the Voluntary Disclosure and Streamlined Procedures Programs, the IRS uses a penalty structure that applies a percentage (generally 27.5% for the Voluntary Disclosure Program and 5% for the Streamlined Procedures Program) to the highest aggregate annual account balance. Using the illustration from above, the FBAR penalty under the Voluntary Disclosure Program would be $137,500 ($500,000 times 27.5%) and the FBAR penalty under the Streamlined Procedures Program would be $25,000 ($500,000 times 5%). Both of these penalty amounts are substantially lower than the FBAR penalties under the program in existence prior to the new guidelines. 

The new guidelines simplify the FBAR penalty computation process and the penalty is now more favorable to taxpayers. In the case of non-willful FBAR penalties, the annual penalty will be limited to $10,000 per year, regardless of the number of accounts or total account balance. This change means that the maximum non-willful FBAR penalty will be $60,000 ($10,000 per year over the 6 year FBAR statute of limitations period). This compares very favorably to the $240,000 penalty from the illustration described above. 

The new guidelines also make similar significant changes for willful FBAR penalties, which are now limited in most cases to 50% of the highest annual aggregate balance in the unreported accounts over the years under examination. Using the $500,000 account balance from the illustration above, the new willfulness FBAR penalty will now be $250,000 as opposed to the $1,500,000 under the prior guidelines. 

The new guidelines, while much more taxpayer friendly than the prior guidelines, do raise questions for taxpayers to consider when they focus on the approach to use for reporting offshore accounts. Assume that FBARs have not been filed for 6 years (the FBAR statute of limitations period) and the average annual account balance was $500,000. Also assume that the non-willful FBAR penalty would apply. The FBAR penalty is as follows depending on the approach used: 

  1. Quiet Disclosure with IRS Audit-$10,000/year:  $60,000
  2. Streamlined Procedures Program-5%:  $25,000
  3. Voluntary Disclosure Program-27.5%:   $137,500

Given the low 5% penalty under the Streamlined Procedures Program, that Program will actually result in the lowest FBAR penalty until the average annual account balance exceeds $1,200,000. 

If the willfulness penalty would apply, the amount of the FBAR penalty is also very different depending on the approach used. Again assume that FBARs have not been filed for 6 years (the FBAR statute of limitations period) and the average annual account balance was $500,000. The FBAR penalty is as follows depending on the approach used: 

  1. Quiet Disclosure with IRS Audit-50%:  $250,000
  2. Streamlined Procedures Program-5%: $25,000
  3. Voluntary Disclosure Program-27.5%:  $137,500 

Although there are other issues to consider when deciding between quiet disclosure (i.e., simply filing late FBARs), the Streamline Procedures Program and the Voluntary Disclosure Program, the amount of the FBAR penalty is often the central issue in deciding which compliance approach to consider. 

Although not specifically addressed in the new guidelines, it is apparent that in most cases the FBAR penalty will actually be lower if a taxpayer participates in the Streamlined Procedures or Voluntary Disclosure Programs instead of a quiet disclosure that triggers an IRS audit. This economic result is consistent with the comments by the IRS over the last several years suggesting that delinquent FBAR filers should participate in a designated disclosure program rather than file FBARs and amended income tax returns using a quiet disclosure. 

In addition to the new guidelines, the date for filing FBARs was changed by the recently enacted Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. Prior to the Act, FBARs were required to be filed by June 30th and there was no ability to extend this date. For tax years beginning after December 31, 2015, the Act requires FBARs to be filed by April 15th and taxpayers can now obtain a 6 month filing extension. For individual taxpayers, this means that FBARs for 2015 will continue to be due by June 30, 2016 (with no extension available), but FBARs for 2016 will be due by April 15, 2017 (with an extension option available until October 15, 2017). These changes align the filing dates (and extension periods) with the individual income tax return (and extension) due dates. 

As we have mentioned in prior Tax Alerts on FBAR and offshore account issues, we strongly recommend that taxpayers discuss their alternatives with their tax advisors and become compliant as quickly as possible. Contact John Eagan (212-868-4835; eaganj@whiteandwilliams.com), Kevin Koscil (215-864-6827; koscilk@whiteandwilliams.com) or Suzanne Prybella (215-864-7188; prybellas@whiteandwilliams.com) for more information. 

IRS Circular 230 Notice: To ensure compliance with certain regulations promulgated by the U.S. Internal Revenue Service, we inform you that any federal tax advice contained in this communication is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code, or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein, unless expressly stated otherwise.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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